Credit Based Insurance Scores

Are you paying more than your neighbor for car insurance?

Credit based insurance scores can cost you plenty. Why? Because many insurance companies believe that if you have poor credit you're more likely to file an insurance claim. As a result, they use credit based insurance scores to price insurance premiums or to decide whether to even approve your insurance policy. However, they rarely disclose your insurance credit score or how they use them.

This is part of the "new normal" of credit scores. Businesses are increasingly using credit scores as a means of pricing goods and services. Different consumers are charged different prices, based upon their credit scoring.

In many instances it may be difficult to see a correlation between their business risk and your credit. For example, many consumer groups argue your credit history has nothing to do with the probability you will have an auto accident!

What are Credit Based Insurance Scores Anyway?

Insurance companies point out that statistically, consumers with certain "high risk" behaviors, like high credit account balances, actually file more insurance claims. So they are justified in using credit information to develop credit insurance scores.

Fair Isaac Corporation is the company that developed the FICO scoring model. They've gone on record as saying "...[the] insurance score is only based 40 percent on payment history, with the remaining 60 percent stemming from credit limits and balances, the age of the consumer's earliest account, if they shopped for loans, and the types of loans they hold."

Basically, some combination of these credit report items is used to calculate your credit based insurance scores. Some insurance companies use scoring models developed by credit scoring companies like Choice Point or Fair Isaac. But many other insurance companies use your credit information to create their own models for developing credit based insurance scores.

To make matters more complex, each insurance company weighs your credit information differently. Also, you won't know whether your insurance carrier uses the insurance score for only new applicants or for renewal of existing policies as well.

Why do they use credit-based insurance scores?

Consumer Reports argues that credit-based insurance scores are discriminatory against low income consumers and minority groups. Their studies show these two groups tend to have lower credit limits and obtain loans from finance companies. These are two of the credit report items used to calculate insurance scores. As a result, low income and minority groups both have disproportionately lower insurance scores.

Also, a 2002 Federal Reserve study showed significant delays in posting of payments to consumer credit accounts. As a result, you may pay off your balance timely each month, but it may not be reflected in your credit report for weeks. So depending upon when your insurance score is calculated, your true balances may not be considered.

These are just a few of the criticisms of using credit-based insurance scores. However, insurance companies are insistent that there is a direct correlation between the credit report data they track and the filing of insurance claims. They believe consumers with "irresponsible" financial behavior are more likely to have an accident or file an insurance claim. So as I've said before, credit scores are here to stay!

Tips to Help Reduce Your Insurance Costs

Currently, there's no way to determine exactly how much your credit information impacts your insurance scores or insurance premiums; but here's a few tips to help minimize your insurance costs:

1. Get a free copy of your credit reports from www.annualcreditreport.com and learn how to fix your own credit, or hire a reputable credit repair organization to help legally improve your credit.

2. As a general rule, certain credit accounts like department store accounts, retail stores, and other non-bank type credit accounts can negatively impact your credit score.

3. Insurance companies like to see major credit card accounts like Visa, MasterCard Discover and American Express.

4. Maintain low credit account balances. Paying down your monthly balances to 20% of your credit limit is a good rule of thumb.

5. Limit the number of credit inquiries to a minimum. Try not to incur anymore than 2 or 3 per year.

6. If you receive a high insurance quote or if you're denied insurance, request your insurance company to re-score your application. Request to know your scoring and what factors influenced your quote. If necessary, provide an explanation of any special circumstances like divorce, unemployment, etc.